Governments should boost spending to contain the Covid-19 economic fallout
Broader monetary stimulus such as policy rate cuts or asset purchases can lift confidence and support financial markets
By Gita Gopinath
Published: Tue 10 Mar 2020, 7:00 PM
Last updated: Tue 10 Mar 2020, 9:24 PM
The human costs of the coronavirus outbreak have risen at an alarming rate and the disease is spreading across more countries.
The first priority is clearly to keep people as healthy and safe as possible. Countries can help by spending more to boost their health systems, including on personal protective equipment, screening, diagnostic tests, and additional hospital beds.
Without a vaccine to stop the virus, countries have taken measures to limit its spread, like travel restrictions, temporary school closures, and quarantines. Such measures also buy valuable time to avoid overwhelming health systems.
The economic impact is already visible in the countries most affected by the outbreak. For example, in China, manufacturing and service sector activity declined dramatically in February. While the drop in manufacturing is comparable to the start of the global financial crisis, the decline in services appears larger this time -reflecting the large impact of social distancing.
The global supply and demand for dry bulk shipping stocks such as building materials and commodities has also dropped similar to during the most acute phase of the global financial crisis, reflecting curtailed economic activity associated with the unprecedented containment effort. This drop was not seen in recent epidemics or after the 9/11 attacks.
Supply and demand shocks
The coronavirus epidemic involves both supply and demand shocks. Business disruptions have lowered production, creating shocks to supply. And consumers' and businesses' reluctance to spend has lowered demand.
On the supply side, there is a direct reduction in the supply of labour from unwell workers, from caregivers who have to take care of kids because of school closures, and sadly, from increased mortality. But an even larger effect on economic activity occurs because of efforts to contain the spread of the disease through lockdowns and quarantines, which lead to a drop in capacity utilisation. In addition, firms that rely on supply chains may be unable to get the parts they need, whether domestically or internationally. For example, China is an important supplier of intermediate goods to the rest of the world, particularly in electronics, automobiles, and machinery and equipment. The disruption there is already having knock-on effects to downstream firms. Together, these disruptions contribute to a rise in business costs and constitute a negative productivity shock, reducing economic activity.
On the demand side, the loss of income, fear of contagion, and heightened uncertainty will make people spend less. Workers may be laid off, as firms are unable to pay their salaries. These effects can be particularly severe on some sectors such as tourism and hospitality - as seen for example in Italy. Since the start of the recent US equity market selloff on February 20, 2020, airline stock prices have been hit disproportionately, in line with the post-9/11 terrorist attacks but lower than after the global financial crisis. In addition to these sectoral effects, worsening consumer and business sentiment can lead firms to expect lower demand and reduce their spending and investment. In turn, this would exacerbate business closures and job losses.
Financial effects and spillovers
As seen in recent days, borrowing costs can rise and financial conditions tighten, as banks suspect consumers and firms may be unable to repay their loans on a timely basis. Higher borrowing costs will expose financial vulnerabilities that have accumulated during years of low interest rates, leading to a heightened risk that debt cannot be rolled over. A reduction of credit could amplify the downturn arising from the supply and demand shocks.
And when these shocks are synchronised across many countries, the effects can be further amplified through international trade and financial linkages, dampening global activity and pushing commodity prices down. Oil prices have fallen dramatically in recent weeks and are about 30 per cent below their levels at the start of the year. Countries reliant on external financing could find themselves at risk of sudden stops and disorderly market conditions, possibly requiring foreign exchange intervention or temporary capital flow measures.
Targeted economic policies are needed
Considering that the economic fallout reflects particularly acute shocks in specific sectors, policymakers will need to implement substantial targeted fiscal, monetary, and financial market measures to help affected households and businesses.
Households and businesses hit by supply disruptions and a drop in demand could be targeted to receive cash transfers, wage subsidies, and tax relief, helping people to meet their needs and businesses to stay afloat. For example, among other measures, Italy has extended tax deadlines for companies in affected areas and broadened the wage supplementation fund to provide income support to laid-off workers, Korea has introduced wage subsidies for small merchants and increased allowances for homecare and job seekers, and China has temporarily waived social security contributions for businesses. For those laid off, unemployment insurance could be temporarily enhanced, by extending its duration, increasing benefits, or relaxing eligibility. Where paid sick and family leave is not among standard benefits, governments should consider funding it to allow unwell workers or their caregivers to stay home without fear of losing their jobs during the epidemic.
Central banks should be ready to provide ample liquidity to banks and non-bank finance companies, particularly to those lending to small- and medium-sized enterprises, which may be less prepared to withstand a sharp disruption. Governments could offer temporary and targeted credit guarantees for the near-term liquidity needs of these firms. For example, Korea has expanded lending for business operations and loan guarantees for affected small- and medium-sized enterprises. Financial market regulators and supervisors could also encourage, on a temporary and time-bound basis, extensions of loan maturities.
Broader monetary stimulus such as policy rate cuts or asset purchases can lift confidence and support financial markets if there is a marked risk of a sizable tightening in financial conditions (with actions by large central banks also generating favourable spillovers for vulnerable countries). Broad-based fiscal stimulus consistent with available fiscal space can help lift aggregate demand but would most likely be more effective when business operations begin to normalise.
Considering the epidemic's broad reach across many countries, the extensive cross-border economic linkages, as well as the large confidence effects impacting economic activity and financial and commodity markets, the argument for a coordinated, international response is clear. The international community must help countries with limited health capacity avert a humanitarian disaster. The IMF stands ready to support vulnerable countries with different lending facilities, including through rapid-disbursing emergency financing, which could amount up to $50 billion for low-income and emerging market countries.
Gita Gopinath is the chief economist at the International Monetary Fund